It’s been a while since we published a case study article, and today I am sharing a case study of an out-of-state BRRR Strategy investment of a duplex in Chattanooga, Tennessee. This investment is unique because it was also part of a 1031 exchange.
In this article, you will learn through this case study example how I found the property, how I was able to use a cash offer to get a lower offer accepted, how I managed a renovation from out of state (and without ever seeing the property), and how the refinance process worked.
From the beginning…
In October 2019, we made the decision to sell the new construction duplex that we built in Everett, Washington. The reason for the sale: it was not a recession-proof investment. We had built the duplex to be used for supported living, and the supported living provider we had lined up backed out at the last minute due to staffing issues.
This forced us to rent each unit to regular tenants at $2,400 per month per side. The numbers were still very good, we were able to recoup our entire initial investment and cash flow roughly $900 per month with regular tenants. But, my concerns about the economy had me wondering if $2,400 per unit in rent was sustainable. So, we sold the duplex in exchange for more affordable units.
We were in Costa Rica on the final day of our 45-day property identification period for the 1031 exchange. We had already purchased an 8-unit in Tennessee and had previously been under contract on an 88-unit self-storage deal that would have allowed us to meet the full 1031 amount.
The self-storage deal ended up falling through, and we needed to spend at least $110,000 or else pay the difference in tax. That same day our Agents Invest deal blast came out, and our Chattanooga Agent Partner shared two duplexes to the Deal List. The price range was exactly where we needed to be, and the returns looked strong. Within minutes we picked one, used DocuSign for the offer, emailed the property address to our 1031 intermediary, and crossed our fingers that our offer would be accepted.
The asking price was $149,900. We offered $140,000 cash. There had been two other offers, but they went with our offer because of the quick close. Plus, we did not have a financing contingency.
The Initial Deal Analysis
One side of the duplex was rented for $500 per month, the other side was vacant. The Agents Invest Agent Partner estimated that fair market rents would be $1,500 total or $750 per month per unit. Tenants paid all utilities. I ran my analysis using $10,000 in renovations, 10% for vacancy, $1,500 for rents, and an ARV of $155,000. We had no idea how much the renovations would cost at this point because no one had been inside and there were no interior photos. I have learned that it’s okay to estimate and verify later, erring on the conservative side.
Want a copy of our quick and easy deal analysis calculator? You can download it here.
The initial analysis was to determine if I wanted to move forward by writing the offer, getting the property under contract with the seller, and paying for inspections along with spending the time to verify my initial assumptions on rents, renovations, and ARV.
The initial analysis is the first step in investing, assuming you have already determined your criteria and gotten pre-approved if using conventional financing. The numbers met our criteria, our offer was accepted, so we moved onto the next stage which is due diligence.
The Inspection + Due Diligence Process
Since no one had been inside the duplex, I asked our Agent Partner to schedule a pre-inspection walk through to get an idea of the interior condition. He verified that the condition was about what we had expected, and we scheduled a home inspection. I requested that he invite his preferred property manager along with a contractor to the inspection so that we could compare everyone’s opinion and get bids to confirm our estimated repairs.
As with any older property, we had a list of items that came up at the inspection, including some foundation settling, an HVAC unit that quit working, electrical issues, and many cosmetic repairs. The bid came back at $6,500 for building renovations. Plus $4,000 for the brand new HVAC unit. We negotiated a seller credit of $9,500. The seller agreed, making our final close price of $130,500.
After the inspection, I followed up with the property manager to get her opinion on the property after the inspection, she verified that the area was desirable, and we discussed after repair rents. Her opinion was that the units would rent for $850 per month per side after updates. I re-ran the numbers again.
The other part of the due diligence process is the lease review. Since there was only one unit occupied we requested copies of their lease agreement, any lease extensions, their move-in condition checklist, payment history, and repair log. The owner provided a very basic lease agreement, an unsigned lease extension, a handwritten payment history, and claimed to have not completed a move-in checklist and had no records of repairs.
This is all too common with self-managing landlords, and frankly, if the deal is a good enough deal I am willing to see past these issues. But, it is very important to know what you are getting into before you buy. Surprises after closing are not ideal.
I also noticed that the tenants’ lease had stated no pets, but during the inspection, it was noted that the tenant had a dog. Since they were in a month-to-month agreement, I requested that we handle this after closing with a new lease to include pet rent.
I want to point out that I was in the driver’s seat throughout this process. You need to do the same when making investment property purchases. Unlike buying a home to live in where the agent typically takes the lead, buying investment properties require more due diligence and project management skills.
I’ve seen many investors get frustrated due to expectations that the agent is going to perform due diligence for them, know to invite property managers and contractors to inspections, run analysis, and more. This is not how investing works, it is up to the investor to take the lead, which is why investor education is so important to me.
We closed on the property in early January using a mobile notary at our home in Washington State. I always verify that the title and escrow company correctly pro-rate rents and transfer security deposits.
I know this may sound crazy to some, but we closed on the property without ever visiting Chattanooga. We did not know anyone that lives there, and we had only seen the property in photos and video. We were completely trusting the opinions of the agent, property manager, home inspector, and contractor.
I bring this up because I know that this is a concern for investors wanting to invest out of state. This is one of the reasons why I founded Agents Invest and the ROI Inner Circle. We want to help investors remove their limiting beliefs about out of area investing, and have a place for investors to share their experiences.
I view real estate investing the same as running a business, it is an unemotional decision to invest in a property, the numbers either make sense or they don’t. You build systems and processes to scale, allowing you to focus on what matters most to you. For me, that is spending quality time with friends and family, giving back to the investing community, and having the freedom to travel the world without the stress of worrying about how to make money.
After reviewing the findings of the inspection and discussing potential rent with the property manager, we came up with a scope of work for the contractor. The existing tenant wanted to stay, so we focused our attention on the vacant unit and deferred maintenance items.
Something I learned about out-of-state investing: every area has a different level of renovation. For example, in the Seattle area, when replacing countertops, we always use a 2cm granite or quartz, it’s relatively inexpensive and we can get higher rents for it.
When discussing finishes in Chattanooga I learned that using granite is rare, so rare that it’s not even used in luxury homes. The laminate countertop installers were booked out, and our contractor suggested we use a butcher block countertop. I would have never considered butcher block had he not suggested it. We were pleased with the results, and the price was very affordable.
The renovation was completed on time and at budget. Another detail to note, prior to closing I had signed up for a new Alaska Airlines credit card and used that credit card to purchase a gift certificate to Home Depot, which allowed us to meet the minimum spend required to earn the signup bonus of 40,000 Alaska Airlines miles. The contractor used the gift card to purchase materials, and using our Home Depot ProX account, we were able to track those receipts.
Our property manager was able to increase the rents on the existing tenant from $500 to $830 per month ($30 was for pet rent), we had to replace the stove and a few minor repairs, and we will update their unit when they move out. They were able to rent the other unit within two weeks for $935 per month. We now receive $1,765 per month in rents. That is $265 per month more than originally anticipated, and we expect to increase that to $1,890 after the remodel of the other unit.
After the renovations were completed, the rent was increased on the existing tenant, and a new tenant was placed in the vacant unit, it was time to refinance. By this time, we were hoping that the duplex would appraise for $165,000 – but the appraiser was more conservative and it came back at $155,000.
Being that this is a cash-out refinance, the new loan requires an LTV of 70% so we will receive $108,500 back. This means we have to leave $32,500 of our own cash in the deal .
But, we are very pleased to be getting a 4% interest rate.
After-Refinance Cash Flow
Using the new rents, 10% for a vacancy rate, 5% for maintenance, 5% for Capital Expenditures (CapEx), and actuals for the rest, my new cash on cash return is 24%. Meaning, in about four years, I would recoup the $32,500 left into the deal with cash flow.
To recap this investment, we traded tax-deferred profits by selling one duplex using the IRS 1031 exchange. This allowed us to trade in one duplex (two units) for two new properties, 10 units total, in Tennessee.
The old duplex was cash flowing approximately $900 per month, which we traded for $2,460 per month in cash flow from the two new properties combined. We gained another $47,000 in equity on this Chattanooga duplex and another $285,000 of equity on the new 8-plex (we’ll do a post on that property later).
We combined strategies, and we attempted to BRRR this duplex, but we came up short on the appraisal. Overall, the numbers still worked, buying this duplex saved us from paying capital gains taxes, and increased our monthly cash flow.
Let me know in the comments below what you think about this deal, would you buy this deal based on the numbers?